The Joker in the Pack

jokerRegister Today for Investigating on the InternetMay 18-19 2016 RVACFES Seminar!

Suddenly everyone in the news, even presidential candidates, seems to be accusing someone else of a conflict of interest.  It may be that an exact definition would be helpful in clearing the air and clarifying matters a little so as to identify the real joker in the corporate pack.  From a fraud examiner’s point of view, just what exactly constitutes a conflict of interest?  According to the ACFE a conflict of interest occurs when an employee, manager, or executive has an undisclosed economic or personal interest in a transaction that adversely affects the company. Unaware that its employee has divided loyalties, the company is taken advantage of by the fraudster. As with other corruption cases, in a conflict of interest scheme an employee exerts his influence to the company’s detriment. In many cases, the fraudster does not benefit economically; instead, he uses his influence for the benefit of a friend or relative.

Motive is the difference between a bribery scheme and a conflict of interest scheme. For instance, if an employee approves payment on a fraudulent invoice submitted by a vendor in return for a kickback, this is bribery. On the other hand, if an employee approves payment on invoices submitted by his own company – a real company, not a shell company – this is a conflict of interest. In the bribery case, the perpetrator receives a kickback. In the conflict of interest case, the perpetrator has a hidden interest in the vendor. Similarly, in a bid-rigging case, an employee influences the selection of a company for which he has a hidden interest, rather than influencing selection of a vendor who has bribed him.

However, many conflict of interest schemes do not mirror bribery or bid-rigging schemes. An employee can use her influence to benefit a company in which she has a hidden interest. Any way in which a fraudster exerts his influence to divert business to his hidden interest company is considered to be a conflict of interest. In a purchasing conflict of interest scheme, an employee purchases goods or services from a company in which he has a hidden interest, resulting in purchases that are typically either overbilled or unnecessary. Employees in purchasing who have access to bidding information determine the bid amounts from other vendors, then pass this inside information to their hidden interest company so it will be better equipped to win the contract. Perpetrators also use bid waivers to avoid a competitive bid process in order to award a contract to their hidden interest company. Or, a fraudster could ignore his employer’s purchasing rotation and direct an inordinate number of purchases or contracts to his hidden interest company. Some fraudsters engage in what is known as a turnaround sale or flip whereby an employee personally purchases goods he or she knows the employer needs, and then sells them to the employer at an inflated price.

Two types of conflict schemes are associated with the victim company’s sales. The first, and most harmful scheme, involves under-billing a vendor in which the perpetrator has a hidden interest. The victim company ends up selling its goods or services below fair market value, which results in a diminished profit margin or loss on the sale, depending upon the size of the discount. The other type of sales scheme involves tampering with the books of the victim company to decrease or write off the amount owed by the employee’s business. For instance, after an employee’s company purchases goods or services from the victim company, credit memos may be issued against the sale, causing it to be written off to contra accounts such as discounts and allowances. In other cases, the perpetrator might not write off the sale but simply delay billing. This delaying tactic is sometimes done as a “favor” to a friendly client, and not considered an outright attempt to avoid paying the bill. The victim company eventually gets paid, but loses the use of the money and the interest that might have been earned on the payment.

In a client diversion scheme, an employee starts his own business and competes directly with his employer. While still employed by the victim company, the employee diverts clients to his own business. In a resource diversion scheme, an employer’s funds and other resources are diverted to the development of an employee’s personal business. A fraudster obtains the resources using a check tampering, billing, payroll, expense reimbursement, or one of the other asset misappropriation schemes discussed so often in this blog. With the exception of the fraudster’s motives, conflict of interest schemes are similar to other asset misappropriation frauds; they are concealed and converted in the same way. In other words, if the fraudster uses a check tampering fraud to commit a conflict of interest crime, then the employee would conceal and convert using the same techniques employed in check tampering frauds. The fraudster can also convert the misuse of influence into personal gain by profiting from the growth or earnings of a hidden interest company.

So what are the red flags? Many of the red flags associated with other fraud schemes also point to a conflict of interest scheme. For instance, while a particular red flag might suggest an employee is committing a fraudulent disbursement scheme, a conflict of interest problem might exist as well. In addition, certain red flags pertain directly to conflict of interest schemes. The following point to some of the warning signs that an employee could have a conflict of interest; the absence of clear company policies regarding an employee’s disclosure of outside interests and the commitment expected of the employee to act in the company’s best interests. Likewise, complaints, especially if they are frequent or in sales and purchasing. If a particular vendor is being favored, then competing vendors might file complaints. In addition, employee complaints about the substandard service of a favored vendor may lead to the discovery of a conflict of interest. And finally, a large number of reversals to sales entries.

The ACFE recommends that CFE’s consider proposing the following techniques and procedures to our clients to help prevent and detect conflict of interest schemes …

–Create company policies to directly address conflict of interest issues. Outline the responsibilities of employees to disclose all outside interests that might conflict with the interests of the company. Make sure that employees and vendors are aware of the company’s policies concerning conflicts of interests. Require employees to complete an annual disclosure statement; this may reveal potential conflicts of interest.

–Provide vendors with a direct line to complain about unfair practices, and keep a descriptive log of vendor complaints. Review the log regularly to identify patterns that might point to a fraud scheme. Also, devise a way for employees to discreetly let the company know of suspicious activities.

–Compare vendor addresses with employee addresses, and look for vendors whose addresses are listed as post office boxes. This is the same investigative technique used to locate bogus vendors.

–Review vendor ownership files. When a vendor is chosen, a complete file of vendor ownership should be maintained. If the vendor is required to update the file annually, then changes in ownership also will be disclosed. A comparison of vendor ownership and employee files may reveal conflicts of interest.

–When an employee leaves the company, compare the address of his new employer to vendor addresses. If there is a match, a possible conflict of interest may have existed.

–Interview purchasing personnel. Employees are generally the first to observe that a vendor is receiving favorable treatment. Ask employees if particular vendors are receiving favorable treatment; this may uncover conflicts of interest that would otherwise go unnoticed.

Leave a Reply